The Political Economy of Trade Policy Flashcards
1
Q
The cases for free trade?
A
- Argument that producers and consumers allocate resources most efficiently when governments don’t distort market policies through trade policy – national welfare of a small country is highest with free trade – with restricted trade, consumers pay higher prices and consume too little while firms produce too much
- However, bc tariff rates are already low for most, estimated benefits of moving to free trade are only a small fraction of national income for most countries – for world as a whole, protection costs less than 1% of GDP – gains are somewhat smaller for advanced economies such as US and larger for poorer developing countries
- Free trade allows firms or industry to take advantage of economies of scale – protected markets limit gains from external EOS by inhibiting concentration of industries – too many firms to enter the protected industry – scale of production of each firm becomes inefficient
- Provides competition and opportunities for innovation – dynamic benefits – providing entrepreneurs an incentive to seek new ways to export/compete with imports
- Avoids loss of resources through rent seeking – spend time and other resources seeking quota rights and the profit they will earn
- Political argument says free trade is the best feasible political policy, even though may be better policies in principle – any policy deviating from free trade would be quickly manipulated by political groups, leading to decreased national welfare
2
Q
The cases against free trade?
A
- For a large country, a tariff lowers the price of imports in world markets and generates a terms of trade gain – this benefit may exceed losses caused by distortions in production and consumption
- A small tariff will lead to an increase in national welfare for a large country – but at some rate, welfare will begin to decease as economic efficiency loss exceeds terms of trade gain
- Could improve national welfare at expense of other countries
- But ignores likelihood that others may retaliate by enacting own trade restrictions
- Export tax (negative export subsidy) that completely prohibits exports leaves a country worse off, but an export tac rate may exist that maximises national welfare through terms of trade – export subsidy lowers terms of trade for large country, export tax raises terms of trade for large country – export tax may raise price of export in world market (as supply is restricted), increasing terms of trade
3
Q
Cases against free trade - domestic market failure?
A
- Domestic market failures may exist causing free trade to be suboptimal – economic efficiency loss calculation using consumer and producer surplus assume markets function well
- Types of market failure inc –
- persistently high underemployment, surpluses that are not eliminated in the market for labour because wages don’t adjust
- persistently high underutilisation of structures, equipment and other capital forms, surpluses that are not eliminated in market for capital bc prices don’t adjust
- property rights not well defined/enforced
- Technological benefits for society discovered through private production, but from which private firms cannot fully profit
- Environmental costs for society cause by private production, but for which private firms do not fully pay
- Sellers that aren’t well informed about the opportunity cost of production or buyers not well informed about value
- Economists calculate marginal social benefit to represent the additional benefit to society from private production – with a market failure, MSB is not accurately measured by the producer surplus of private firms, so that economic efficiency loss calculations are misleading
- Possible that when a tariff increases domestic production, benefit to domestic society will increase due to a market failure
- If production of a good yields extra social benefits (c) not captured as producer surplus, a tariff can increase welfare
- a can be seen as loss of efficiency due to production being distorted
- The domestic market failure argument against free trade is an example of a more general argument called theory of the second best
- Government intervention that distorts market incentives in one market may increase national welfare by offsetting the consequences of market failures elsewhere
- If the best policy, fixing the market failures, is not feasible, gov intervention in another market may be the ‘second best’ way of fixing the problem
- (Import tariffs and import quotas are able to raise production and lower unemployment)
4
Q
Counter arguments?
A
- Economists supporting free trade counter-argue that domestic market failures should be corrected by a “first best” policy: a domestic policy aimed directly at the source of the problem.
- If persistently high underemployment of labour is a problem, then the cost of labour or production of labour-intensive products could be subsidized by the government.
- This policy could avoid economic efficiency losses due to a tariff
- Unclear when and to what degree a market failure exists in the real world.
- Government policies to address market failures are likely to be manipulated by politically powerful groups.
- Due to distorting the incentives of producers and consumers, trade policy may have unintended consequences that make a situation worse, not better
5
Q
Politcal models?
A
Methods of governments maximising political success rather than national welfare
Median Voter theorem
Collective Action
Model combining both
6
Q
Median voter?
A
- Predicts democratic political parties pick policies to court the voter in the middle of the ideological spectrum
- Suppose level of tariff is the policy issue – line up all voters to tariff rate they prefer, starting with those favouring the lowest rate
- Assumptions – two competing political parties – objective of each party is to get elected via majority vote
- What policies will the parties promise to follow? Both will offer the same tariff policy to court the median voter in order to capture the most votes
- This median voter theorem implies a two-party democracy should enact policy based on how many voters it pleases – a policy that inflicts large losses on a few but benefits large number of people
- In theory – deciding to place policy outside the median is not stable and so should converge to the median voter
- If looking at payoff functions which are single peaked, easy to analyse this model
- Look at a model with consumers and producers as voters
- Millions of consumers who want 0% tariff rate – thousands of producers who (for simplicity) want 100% tariff rate
- Median voter will be at 0% due to the millions of consumers
- But trade policy doesn’t follow this – thus something missing from model (lobbying)
7
Q
Collective action?
A
- Political activity often described as a collective action problem –
- While consumers as a group have an incentive to advocate free trade, each individual consumer has no incentive bc his benefit is not large compared to the cost and time required to advocate free trade
- Policies that impose large losses for society as a whole but small loss on each individual may therefore not face strong opposition
- However, for groups who suffer large losses from free trade (e.g., unemployment), each individual in that group has a strong incentive to advocate the policy he desires
- In this case, the cost and time required to advocate restricted trade is small compared to the cost of unemployment
- Thus, small groups of producers able to organise better than large groups of consumers
8
Q
A model of trade policy?
A
- While politicians may win elections partly because they advocate popular policies as implied by the median voter theorem, they also require funds to run campaigns.
- These funds may especially come from groups who do not have a collective action problem and are willing to advocate a special interest policy.
- Models of trade restrictions try to measure the trade-off between the reduction in welfare of constituents as a whole and the increase in campaign contributions from special interests.
9
Q
Which industries are protected?
A
- Agriculture: In the United States, Europe, and Japan, farmers make up a small fraction of the electorate but receive generous subsidies and trade protection.
- Examples: European Union’s Common Agricultural Policy, Japan’s 1000% tariff on imported rice, America’s sugar quota
- Clothing: textiles (fabrication of cloth) and apparel(assembly of cloth into clothing).
- Until 2005, quota licenses granted to textile and apparel exporters were specified in the Multi-Fibre Agreement between the United States and many other nations.
- Phase-out of MFA drastically reduced the costs of U.S. protection, from 14.1b in 2002 (11.8b from textiles and apparel) to 2.6b estimate for 2015 (only0.5b from textiles and apparel).
- They influence politics mainly through lobbying
10
Q
What is lobbying?
A
In politics, lobbying, or advocacy, is the act of lawfully attempting to influence the actions, policies, or decisions of government officials, most often legislators or members of regulatory agencies, but also judges of the judiciary.
11
Q
Welfare costs of US protection ($ billion)?
A
2002 estimate total -14.1
2002 estimate textiles/apparel - 11.8
2015 projected total - 2.6
2015 estimate textiles/apparel - 0.5
12
Q
International negotiations of trade policy?
A
- After rising sharply 1930s, average US tariff rate has decreased substantially from mid 1930s to 1998
- Since 1944, much of the reduction in tariffs and other trade restrictions has come about through international negotiations
- The General Agreement of Tariffs and Trade began in 1947, as a provisional international agreement and replace by WTO in 1995
- Multilateral negotiations mobilise exporters to support free trade if they believe export markets will expand
- This support would be lacking in a unilateral push for free trade – the multilateral approach counteracts the support for restricted trade by importing competing groups
- Multilateral negotiations also help avoid trade war between countries
- A trade war could result if each country has an incentive to adopt protection, regardless of what others do
- All countries could enact trade restrictions, even if it is in the interest of all countries to have free trade
- Countries need an agreement that prevents a trade war or eliminates the protection from one
13
Q
International Trade Agreements - A brief history?
A
In 1930, the United States passed a remarkably irresponsible tariff law, the Smoot-Hawley Act.– Tariff rates rose steeply and U.S. trade fell sharply.
* Initial attempts to reduce tariff rates were undertaken through bilateral trade negotiations:–
* The United States offered to lower tariffs on some imports if another country would lower its tariffs on some U.S. exports.
* Bilateral negotiations, however, do not take full advantage of international coordination.– Benefits can “spill over” to countries that have not made any concessions
14
Q
World Trade Organisation?
A
- In 1947, a group of 23 countries began trade negotiations under a provisional set of rules that became known as the General Agreement on Tariffs and Trade, or GATT.
- In 1995, the World Trade Organisation, or WTO, was established as a formal organisation for implementing multilateral trade negotiations (and policing them).
15
Q
How to WTO negotiations address trade restrictions?
A
- Reducing tariff rates through multilateral negotiations.
- Binding tariff rates: a tariff is “bound” by having the imposing country agree not to raise it in the future.
- Eliminating nontariff barriers: quotas and export subsidies are changed to tariffs because the costs of tariff protection are more apparent and easier to negotiate.– Subsidies for agricultural exports are an exception.– Exceptions are also allowed for “market disruptions” caused by a surge in imports.
